Conduct Risk

Regulators raised the need for cultural change in financial markets behaviour during the aftermath of the 2008 crash, however behaviour/conduct risk have long been an implicit part of financial institutions’
January 25, 2015 - Editor
Category: Basle III

Regulators raised the need for cultural change in financial markets behaviour during the aftermath of the 2008 crash, however behaviour/conduct risk have long been an implicit part of financial institutions’ risk management programmes under Basle II and Basle III.

The recent scandals that have rocked the markets in LIBOR, WMReuters FX fix and a number of similar benchmark f ixings have served as a catalyst for a renewed focus into managing behaviour, and most institutions are now considering or actively pursuing a change-management programme. This is likely to involve a step-change in how staff approach and understand the risks involved in running their business, crucially taking a personal ownership of behaviour. It is no longer acceptable to approach the business with an attitude of ‘what can I get away with’. The new approach has to be ‘is this the correct way to behave’.”

Given that so much of the FX Fixing scandal is alleged to have been organised through chat-rooms, financial institutions across the world are re-examining their internal procedures and manuals with the aim of ensuring that their staff are behaving correctly in their communications and that they can demonstrate this to their regulator. The sheer volume of messages, whether via telephone, email or electronic message platforms, is enormous and having the systems in place to monitor and understand what is being discussed on some kind of automatic basis is a challenge; but one that the financial institutions are actively wrestling with.

Financial institutions are actively pursuing programmes of change. Some started months ago and some are just starting now. Some are already under investigation and others are not so caught up in the scandals; but everyone is aware of the need to demonstrate best practice. Ensuring that all staff are accountable for their own behaviour and understand their own responsibilities requires a sea-change in approach – far more than a box-ticking exercise.

While investment in more advanced automated systems to monitor conversations and trading activity provides an easy win for financial institutions, the more challenging goal of changing culture, altering how traders and salespeople approach the aims of their job, is far more complex to measure and achieve.

Familiarity with a recognised Code of Conduct is a good starting point, not only in training staff but also in their acknowledgment that they understand and will adhere to the Code.

Many banks already have some sort of internal compliance code which staff are meant to follow, however the challenge for banks in this more stringent environment is how far their code should go: too strict and business will be squeezed out by a less strict competition, too light and the business risks behaviour outside of regulation and a possible scandal. A globally recognised Code would be far more transferable and appropriate, removing that concern around where to draw the line. The ACI Code Conduct is the closest to this idea currently and has support from some regulators and central banks already. The work that IOSCO is doing in this area will be highly relevant and interesting – so watch this space as regulatory thinking around a Global Code develops.

So what next?

The key emphasis for true culture change is that any programme has to be owned by the business management and driven through in their daily lives. Anything that is seen as a ‘tick-box’ exercise executed by ‘the compliance team’, will ultimately fail. Whilst the compliance team will often have a major hand in administering a programme, the ownership and responsibility has to sit within the business.

The primary steps to a successful programme would be led by business management who request compliance to draw up a programme outline for approval. Within the compliance department there is normally sufficient resident expertise to understand the core aims and how to navigate the internal structure of the institution; however staffing levels and the ever-increasing compliance workload will often mean that external expertise is beneficial to ensure momentum to this process.

The outline will include management actions to ensure their engagement, from the top down through the chain of command, however matrix based that may appear! Structural elements such as control of chat room usage and monitoring of any conversations are normal; education and testing of correct behaviour, preferably based on a recognised Code of Conduct; ownership by the frontline for their behaviour, signed for and challenged by management under a regular review; the most senior management are a part of this change in approach and a regular item on the Board’s agenda should now be conduct risk, with real discussion attached to the report.

One major lesson learnt over recent years is that demonstrating change will not be effective if left to a group of people outside of the core business. This is a non-trivial piece of on-going work and a challenge for everyone within the business; everyone has to own a part of the solution.

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